352
WHAT’S NEW IN THE SIXTH EDITION:
There are two new
In the News
features on “What’s Wrong with the Poverty Rate?” and “The Root Cause
of a Financial Crisis.”
LEARNING OBJECTIVES:
By the end of this chapter, students should understand:
➢ the degree of economic inequality in our society.
CONTEXT AND PURPOSE:
Chapter 20 is the third chapter in a three-chapter sequence that addresses the economics of labor
markets. Chapter 18 developed the markets for the factors of production. Chapter 19 extended the basic
supply-and-demand model to help explain the wide variation in wages we find in the economy. Chapter
20 addresses the measurement of the distribution of income and looks at the role the government plays
in altering the distribution of income.
KEY POINTS:
• Data on the distribution of income show wide disparity in our society. The richest fifth of families
earns about ten times as much income as the poorest fifth.
INCOME INEQUALITY AND
POVERTY
20
Table 2
Chapter 20/Income Distribution and Poverty ❖ 353
• Political philosophers differ in their views about the role of government in altering the distribution of
income. Utilitarians (such as John Stuart Mill) would choose the distribution of income to maximize
the sum of utility of everyone in society. Liberals (such as John Rawls) would determine the
distribution of income as if we were behind a “veil of ignorance” that prevented us from knowing our
stations in life. Libertarians (such as Robert Nozick) would have the government enforce individual
rights to ensure a fair process but then not be concerned about inequality in the resulting distribution
of income.
CHAPTER OUTLINE:
I. The Measurement of Inequality
A. To understand the distribution of income, we want to address four questions.
1. How much inequality is there in our society?
B. U.S. Income Inequality
1. Table 1 shows the distribution of income in the United States by quintile.
Table 1
Encourage students to bring their textbooks to class on the day that you cover this
chapter so they can see these tables and charts up close while you are discussing
354 ❖ Chapter 20/Income Distribution and Poverty
a. Throughout the past several decades, the bottom fifth of families has received about 4 to
5 percent of income, while the top fifth has received 40 to 50 percent of income.
C. Inequality around the World
1. Figure 1 compares the income distribution in twelve countries.
2. The U.S. has more income inequality than other economically advanced countries (such as
Japan, Germany, Canada, or the United Kingdom), but a more equal distribution of income
than many developing countries (such as South Africa, Mexico, or Nigeria).
D. The Poverty Rate
1. Definition of poverty rate: the percentage of the population whose family income
falls below an absolute level called the poverty line.
a. The poverty rate fell from 22.4 percent in 1959 to a low of 11.1 percent in 1973.
a. Poverty is correlated with race. Blacks and Hispanics are more likely to live in poverty
than are whites.
Figure 1
Figure 2
Table 3
Chapter 20/Income Distribution and Poverty ❖ 355
E. Problems in Measuring Inequality
1. In-Kind Transfers
a. Definition of in–kind transfers: transfers to the poor given in the form of goods
and services rather than cash.
2. The Economic Life Cycle
a. Definition of life cycle: the regular pattern of income variation over a person’s
life.
3. Transitory versus Permanent Income
a. Definition of permanent income: a person’s normal income.
4.
Case Study: Alternative Measures of Inequality
a. A 2008 study by economists at the Federal Reserve Bank of Dallas shows how different
measures of inequality lead to dramatically different results.
5.
In the News: What’s Wrong with the Poverty Rate?
a. It is often difficult to determine who is poor.
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F. Economic Mobility
1. Economic mobility is the movement of people among income classes and occurs often in the
U.S. economy.
II. The Political Philosophy of Redistributing Income
A. Utilitarianism
1. Definition of utilitarianism: the political philosophy according to which the
government should choose policies to maximize the total utility of everyone in
society.
2. Definition of utility: a measure of happiness or satisfaction.
5. However, utilitarians do not believe that all incomes should be equal.
a. Principle #3: People respond to incentives.
B. Liberalism
1. Definition of liberalism: the political philosophy according to which the government
should choose policies deemed to be just, as evaluated by an impartial observer
behind a “veil of ignorance.”
Chapter 20/Income Distribution and Poverty ❖ 357
3. Rawls considered what income distribution a person would consider just if that person did
not know whether he or she would end up at the top, bottom, or in between.
a. Rawls believed that a person would be most concerned about being at the bottom of the
income distribution.
C. Libertarianism
1. Definition of libertarianism: the political philosophy according to which the
government should punish crimes and enforce voluntary agreements but not
redistribute income.
III. Policies to Reduce Poverty
A. Minimum-Wage Laws
1. For workers with low levels of skill and experience, a high minimum wage forces the wage
above equilibrium.
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2. The magnitude of the effect depends on the elasticity of demand for labor.
a. If the demand for labor is elastic, firms will lower employment more than if the demand
is inelastic.
3. Critics of the minimum wage also point out that many teenagers earning the minimum wage
are from middle-class families, so that a high minimum wage does a bad job of targeting the
poor.
B. Welfare
1. Definition of welfare: government programs that supplement the incomes of the
needy.
2. Temporary Assistance for Needy Families (TANF) and Supplemental Security Income (SSI)
are two welfare programs.
4. Proponents argue that being a poor, single mother on welfare is not a life that someone
would choose. Trends also indicate that, while the amount of welfare benefits (adjusted for
inflation) has fallen since the 1970s, the percentage of children living with a single parent has
risen.
5. The Earned Income Tax Credit works like a negative income tax for the working poor.
C. In-Kind Transfers
1. The federal government provides the poor with food stamps and Medicaid.
Chapter 20/Income Distribution and Poverty ❖ 359
D. Anti-Poverty Programs and Work Incentives
1. Many policies for the poor have the unintended effect of discouraging work.
a. A person discouraged from working loses the on-the-job training that a job might offer.
2. Welfare, Medicaid, food stamps, and the Earned Income Tax Credit all have eligibility
requirements that are tied to income level.
a. As a family’s income rises, it becomes ineligible for these programs.
3. One possible solution would be to gradually phase out the benefits gradually as the family’s
income level rises. However, this would raise the costs of these programs substantially.
4. In 1996, the government passed a welfare-reform law that limits the amount of time that any
person can collect welfare.
SOLUTIONS TO TEXT PROBLEMS:
Quick Quizzes
1. The poverty rate measures the percentage of the population whose family income falls below
an absolute level called the poverty line. It tells you something about the distribution of
income at the lower end of the income scale.
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2. Based on the assumption of diminishing marginal utility of income, a utilitarian would favor
some redistribution of income from Pam to Pauline because it would increase the total utility
3. Policies aimed at helping the poor include minimum-wage laws, welfare, a negative income
tax, and in-kind transfers. Minimum-wage laws can help the working poor without any cost
to the government but have the disadvantage of causing unemployment among some
Questions for Review
2. The United States has a more unequal distribution of income than countries like Germany
3. In the U.S. population, the groups most likely to live in poverty are blacks and Hispanics,
children, and families headed by a female adult without a spouse present.
4. Since people may have temporarily high or low income and since income varies over the life
5. A utilitarian would like everyone to have equal incomes, but would recognize that
redistributing income distorts incentives, so would proceed only part way to that goal. A
6. In-kind transfers are beneficial because they ensure that the poor get what they need most.
In particular, they get food and shelter instead of alcohol and drugs. But in-kind transfers
7. Antipoverty programs can discourage the poor from working because they effectively tax
away earnings by significantly reducing benefits when a person earns income. This
Chapter 20/Income Distribution and Poverty ❖ 361
Problems and Applications
1. The factors contributing to the increase in income inequality in the United States during the
2. The percentage of children in families with income below the poverty line is almost twice the
3. Students’ current incomes are substantially less than their permanent incomes, so current
4. a. To increase economic mobility within a generation, the government could support
training programs (to provide skills to unskilled workers) and workfare instead of welfare
(to help the poor increase their incomes).
5. Community 1 has ten families with income of $100,000 each and ten families with income of
$20,000 each. Community 2 has ten families with income of $200,000 each and ten families
with income of $22,000 each.
a. Community 2 has more unequal income than Community 1. In Community 2 the rich
6. a. Leaks in the bucket are caused by the administrative costs of redistributing income,
people who lie about their income to cheat the system, and the fact that labor supply is
elastic, so that redistributive taxes reduce labor supply.
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7. a. A utilitarian would argue that the marginal utility of income for the person with an
income of $10,000 is higher than the marginal utility of income for someone with an
8. a. If people received cash instead of Medicaid benefits, it is unlikely that they would spend
as much on health care. Instead, they would purchase other things they want or need.
9. a. Since the woman receives a smaller TANF benefit when she earns a dollar more, she will
be less likely to work. Thus, the labor supply of low-income women will be lower as a
result of the TANF program.
10. Utilitarians and liberals would be in favor of this policy. The marginal utility of providing
healthcare to a poor person is likely to be greater than the marginal utility of the tax dollars